Does Uncertainty Drive Business Cycles? Using Disasters as a Natural Expeiment

Scott Ross Baker, Nicholas Bloom

Research output: Working paper

Abstract

A growing body of evidence suggests that uncertainty is counter cyclical, rising sharply in recessions and falling in booms. But what is the causal relationship? Does rising uncertainty drive recessions, or is uncertainty just an outcome of economic slowdowns? To investigate this we construct cross country panel data on stock market levels and volatility as proxies for the first and second moments of business conditions. We then build a panel of indicators for natural disasters, terrorist attacks and political shocks, and weight them by the change in daily newspaper coverage they induce. Using these shocks to instrument our stock market proxies for first and second moment shocks, we find that both shocks are highly significant in driving business cycles.
Original languageEnglish (US)
Number of pages24
StatePublished - Apr 26 2011

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